CoRisk: measuring systemic risk through default probability contagion

We propose a novel systemic risk measurement model, based on stochastic processes, correlation networks and conditional probabilities of default.For each country we consider three different spread measures, one for each sector of the economy (sovereigns, corporates, banks), and we model each of them as a linear combination of two stochastic processes: a country-specific idiosyncratic component and a common systematic factor. We then build a partial correlation network model, and by combining it with the spread measures we derive the conditional default probabilities of each sector. Comparing them with the unconditional ones, we obtain the CoRisk, which measures the variation in the probability of default due to contagion effects. Our measurement model is applied to understand the time evolution of systemic risk in the economies of the European monetary union, in the recent period. The results show that, overall, the sovereign crisis has increased systemic risks more than the financial crisis. In addition, peripheral countries turn out to be exporters, rather than importers of systemic risk, and, conversely, core countries.